Sep 7, 2020
Written by:
Ella Vincent
A zero-sum game may have a great impact on investors. It can beneficial to some and detrimental to others in a bull market. This TradingSim article will explain what a zero-sum game is and how it affects investors. In the article, I will also detail how the belief in zero-sum games can be altered and changed to an approach that benefits all investors.
According to researcher Rozycka-Tran, a zero-sum game has the following definition:
“A general belief system about the antagonistic nature of social relations, shared by people in a society or culture and based on the implicit assumption that a finite amount of goods exists in the world, in which one person’s winning makes others the losers, and vice versa a relatively permanent and general conviction that social relations are like a zero-sum game. People who share this conviction believe that success, especially economic success, is possible only at the expense of other people’s failures,” wrote Rozycka-Tran.
In a zero-sum game is a game in which there is one clear winner and one clear loser. For example, there is a zero-sum game in basketball. If the Los Angeles Lakers are playing the Miami Heat and the Lakers win, they are the clear winner. In the zero-sum equation, in order for the Lakers to win, the Heat have to be the losers.
In economics, there is also the belief there are two sides of a battle. If one side is victorious, the other side must suffer a defeat.
Gordon Gekko, the ruthless main character in the classic movie Wall Street, believed that trading was a zero-sum game. In the high-powered time of the ’80s when traders competed against each other on the Wall Street trading floor, Gekko saw trading as a game of clear winners and losers. If one trader gained profits, another trader had to suffer defeat as a result.
“It’s not a question of enough, pal. It’s a zero-sum game, somebody wins, somebody loses. Money itself isn’t lost or made, it’s simply transferred from one perception to another,” said the fictional trader.
The recent trade war between the U.S. and China amplified the belief in a zero-sum game. During the impasse, St. Louis Fed Senior Economic Education Specialist Scott Wolla wrote about the trade impasse in 2019.
“Many people suspect that international trade operates as a zero-sum game. That is, they think it is like a sporting event—a competition with rules that ends with a winner and a loser. Specifically, people sometimes think that if our trading partners are gaining through international trade, the United States must be losing,” wrote Wolla.
“In this view, exported goods represent a ‘win’ for the economy and imported goods represent a ‘loss’ for the economy,” added Wolla.
In the midst of the standoff, former ambassadors spoke about how President Donald Trump viewed the U.S. -China trade war. David Adelman is a former ambassador to Singapore. He noted that the trade impasse almost plunged the stock market into a bear market.
“He[President Trump] views trade, and he views even security issues, as a zero-sum game — if he sees one country benefiting or one of America’s counterparties benefiting, he makes the assumption that it must be coming at the cost of the American economy,” noted Adelman.
“So I think it’s not too far-fetched to see the President begin to look around the world and use this very blunt instrument to prosecute his case,” added Adelman.
Goh Chok Tong is Emeritus Senior Minister of the Republic of Singapore. He also doesn’t see the U.S.-China trade war as a zero-sum game.
“Strategic competition between the US and China seems inevitable, but it does not have to be a zero-sum game. Nor should it close off opportunities for mutually beneficial cooperation,” said Goh.
Goh advocates for a more measured approach to trade policy.
‘This moderate voice is… a voice for peace and stability, growth and prosperity, and an interdependent rule-based multinational order that is not reliant on the benevolence of superpowers,” said Goh.
In one zero-sum game definition, there is rampant inequality. Shai Davidai is a Columbia Business School assistant professor. In an essay, he noted that the imbalance in a zero-sum game leads to binary thinking that can hurt people.
“It’s this seesaw view of the world where we can’t all be winning,” said Davidai.
In the essay, he also noted that zero-sum thinking in trade or economics leads to a limited solution to problems.
“Zero-sum rhetoric blinds us to solutions. It’s much easier to say, ‘It’s us versus them,’ than thinking, ‘It’s us and them.’ The issue is many of the problems that are really pressing in the U.S. and the world — climate change, inequality — all of those issues affect everyone. But they require broad support from different people and different groups,” added Davidai.
In addition to Davidai, law professor Ilya Somin also thinks that zero-sum game thinking is intuitive to many people.
“It’s intuitive to think in the very short term that more for some people necessarily means less for others,” Somin says. “accept fallacies — like, there’s a fixed number of jobs so if I get a job there’s fewer jobs for everyone else,” said Somin.
For many economists, the zero-sum approach hurt the stock market. The University of Chicago’s Steven Davis commented that the Trump Adminstration’s policy created uncertainty on Wall Street.
He noted that the policy led to a “capricious, back-and-forth character that amplifies uncertainty and undermines a rules-based trading order.”
Davis also noted that there was a drag on international trade “by leading firms to delay or [forgo] investments and hiring, by slowing productivity-enhancing factor reallocation, and by depressing consumption expenditures.”
As a result of the U.S. -China trade war, there was a reaction from Wall Street. Research from the Federal Reserve shows a detrimental effect on the stock market. Mary Amiti, an economist at the Federal Reserve, said that the U.S.- China trade impasse caused a major reduction in the market value of many firms.
“We find that U.S. and Chinese tariff announcements lowered U.S. aggregate equity prices in our sample of close to 3,000 listed firms by 6.0 percentage points: a $1.7 trillion reduction in market value for our sample of listed firms,” said Amiti.
While many economists say a zero-sum strategy didn’t work , others disagree. Economics expert Marc Cherry said the U.S.- China trade war didn’t hurt the economy too badly.
“Such actions from nations as influential as the US and China don’t come without an impact that affects people from all around the world. In this instance, a variety of shifts have left most markets a little worse for wear, but most drastic damage has been avoided”, said Cherry.
In another example of a zero-sum game trade policy, the semiconductor industry in 2018 was also caught up in the U.S.-China trade war. Because many semiconductors are made in China, the U. S. tried to impose tariffs on Chinese imports. Myson Robles-Bruce is a semiconductor value chain researcher. He noted that the zero-sum approach to tariffs would hurt the semiconductor industry.
“For the semiconductor space, the escalating tariffs dispute between the United States and China will be a bruising zero-sum game. He believes it will be “injurious to both sides in which there are no winners,” said Robles-Bruce.
“A tariff war between the world’s two biggest makers and consumers of semiconductors is likely to spread throughout the vast electronics supply chain,” said Robles-Bruce. He notes it’s “involving multitudes of markets, trades, and businesses. Both American and Chinese companies could end up suffering.”
“While it is true that the United States has tremendous leverage over China in chip design, China has immense power in the semiconductor supply chain. In this sense, both countries are needed to drive the industry. Businesses must then absorb somehow the increased costs resulting from the tariffs, or pass them on to consumers,” added Robles-Bruce.
Robles-Bruce believes that the zero-sum approach to trade doesn’t benefit America.
“There are no winners, ” added Robles-Bruce.
In 2018, Trump imposed tariffs on 25% of Chinese imports, including semiconductor chips. Devi Keller is director of policy for the Semiconductor Industry Association. She noted that China retaliated with hefty tariffs of its own on American imports into China. Keller commented that China could become a semiconductor leader with hefty American taxes on their chips.
“China is champing at the bit to assume a leadership role in semiconductor technology, especially with regard to chip manufacturing,” wrote Keller.
Keller is against a zero-sum solution to the trade war. She advocates alternative answers to the semiconductor battle.
“The most effective way for U.S. policymakers to attract semiconductor manufacturing is not tariffs, but financial incentives like federal grants, R&D[research and development] funding, and tax credits to build fabs and research facilities,” said Keller.
While Robles-Bruce thinks a zero-sum game is hurtful, others think there was little effect on investors’ portfolios.
Ajit Manocha is CEO at chip industry association, Semi. He believes that the zero-sum approach to trade didn’t have a great impact on the industry.
He thinks that the “tariff has not really slowed down the industry.”
In addition to the trade war, many see the stock market as a zero-sum game. Lawrence E. Harris is a professor of finance. He summarized zero-sum trading.
“Winning traders can only profit to the extent that other traders are willing to lose. Traders are willing to lose when they obtain external benefits from trading. The most important external benefits are expected returns from holding risky securities that represent deferred consumption. Hedging and gambling provide other external benefits,” wrote Harris.
“Markets would not exist without utilitarian traders. Their trading losses fund the winning traders who make prices efficient and provide liquidity,” added Harris.
Harris wrote about how traders need to lean into the zero-sum approach to become a better trader.
“On any given transaction, the chances of winning or losing may be near even. In the long run, however, winners profit from trading because they have some persistent advantages that allow them to win slightly more often or occasionally much bigger than losers win,” wrote Harris.
“To trade profitably in the long run, you must know your edge, you must know when it exists, and you must focus your trading to exploit it when you can. If you have no edge, you should not trade for profit,” wrote Harris.
“If you know you have no edge, but you must trade for other reasons, you should organize your trading to minimize your losses to those who do have an edge. Recognizing your edge is a prerequisite to predicting whether trading will be pro table,” added Harris.
Investor John Bogle wrote that trading is a zero-sum game because of the high costs of losses in a bear market.
“Trading is inevitably a zero-sum game before costs, and a ‘loser’s game’ after deducting the high costs of all those transactions. In economic terms, trading is a ‘rent-seeking’ function which subtracts value from Wall Street’s customers,” wrote Bogle.
Economist Paul Samuelson also noted that in trades, there are clear winners and losers.
“For every trader betting on higher prices, another is betting on lower prices. These trades are matched. In the stock market, all investors (buyers and sellers) can profit in a rising market, and all can lose in a falling market. In futures markets, one trader’s gain is another’s loss,” noted Samuelson.
Another trading expert Dennis Gartman spoke about zero-sum trading.
“In the world of futures speculation, for every long there is an equal and opposite short. That is, unlike the world of equity trading where there needn’t be equal numbers of longs versus shorts, in the world of futures dealing there is. Money is neither made, nor lost, in futures; it is simply moved from one pocket to the next as margins are swapped at the close of trading each day,” said Gartman.
“Thus, every time there is a buyer betting that prices shall rise in the future, there is an equal seller taking the very opposite bet, betting that prices will fall,” added Gartman.
Santa Clara University finance professor Meir Statman noted that financial advisors should tell their clients that trading can be a zero-sum game.
“Advisors have to reach out and speak with them — not to assure them that everything is going to be fine, because you cannot promise what you cannot deliver. But they have to talk about contingencies. What is likely to be least helpful is to engage in trading strategies or rearranging your investments. If you sell, somebody buys; and one of you will turn out to be wrong. But you don’t know who it will be. That’s a zero-sum game,” noted Statman.
Financial expert Henry Blodget also sees trading as a zero-sum game. He said trading as is a zero-sum game that will be a disadvantage to day traders if they’re not experienced.
“Trading is a zero-sum game: Market moves aside, every dollar won by one trader comes out of the pocket of another trader. Day traders competing against Wall Streeters is the equivalent of a college football team (or Pee Wee team, depending on the day-trader’s skill) competing against a pro team,” said Blodget.
Trader Oddmund Goette believes that trading is a zero-sum game. He said in an interview that day trading has few winners and many losers.
“Trading is what Nassim Taleb would call a highly scalable profession where just a few winners take most of the profits. You rarely read about the dentist or lawyer making $500,000 a year with very little variation and randomness, but admire the successful trader making 10 million,” said Goette.
“However, for every winner, there are so many losers. We tend to forget that the results of certain professions are pretty binary: you either become very rich (and/or famous), or you end up with nothing (literally),” said Goeette.
If traders are day trading as part of a work-from-home opportunity, they should be cautious about their trades to avoid large losses.
In addition to trading being a zero-sum game, many experts see forex trading as a zero-sum game as well. Robert Johnson is a professor of finance at Creighton University’s Heider College of Business. He sees forex trading as more high-stakes than trading stocks.
“Investing in currencies, whether traditional currencies or cryptocurrencies, is fundamentally different than investing in stocks, bonds, or real estate, ” said Johnson.
“Over the long term, investing in the stock market is a positive-sum game,” added Johnson.
However, Johnson sees investing in foreign exchange (forex) as a zero-sum game. For example, a trader bets on the U.S. dollar against the Japanese yen. If the dollar falls, the yen rises. So, if the yen rises, the trader is a loser in the forex market. Therefore, there is a clear winner and loser in forex trading.
“On the other hand, over both the short and long term, investing in currencies is a zero-sum game,” Johnson says. “When the U.S. dollar strengthens versus the yen, those holding U.S. dollar positions win and those holding yen positions lose an equal and opposite amount.”
In addition to forex, trading derivatives and options are seen as a zero-sum game. Financial analyst Justin Grossbard noted that trading derivatives requires clearly defined losers and winners.
“Given trading derivatives is a zero-sum game, traders are always looking for an edge. Even receiving market news a split second ahead of the masses could result in significant gains. Its why most brokers talk up the low latency of their servers and connection speeds. News and pricing communicated fast and in real time to traders is imperative as most money is made in the period of time leading up to and right after sensitive market news is released,” said Grossbard.
Financial expert Henry Blodget also says day trading is a zero-sum game. He believes that day traders are competing against more experienced traders on Wall Street to capture a lion’s share of profits.
“Trading is a zero-sum game: Market moves aside, every dollar won by one trader comes out of the pocket of another trader. Day traders competing against Wall Streeters is the equivalent of a college football team (or Pee Wee team, depending on the day-trader’s skill) competing against a pro team,” said Blodget.
While trading forex or options can be a zero-sum game, many see investing as a positive-sum game. Analysts at UBS, led by Mark Haefele, write that investing is not a zero-sum game. They argue that because the stock market grows and expands, there isn’t a clear winner or loser in investment. One reason investing isn’t a zero-sum game is because the Federal Reserve continues to help Wall Street.
“Stocks remain supported by Fed liquidity. Research shows that entering the market all at once has historically offered the best outcomes—even at record highs, where subsequent 12-month returns have averaged 12% since 1960,” said the analysts.
Citi economist Tobias Levkovich believes that stock trading is not a zero-sum game .
“The stock market is not a zero-sum game. There’s a mistaken tendency to think that a dollar that leaves the equity market translates into a dollar less in the stock market. Equity prices often move on a change in perception typically caused by an upside earnings surprise, a takeover announcement, lowered guidance, etc., such that double-digit changes can occur without a single dollar even changing hands at that moment. Hence, while flows matter, they aren’t everything one should consider,” said Levkovich.
“Other facets can be as crucial to the understanding of likely stock price direction including economic trends, investor sentiment,” added Levkovich.
In addition to UBS analysts, many financial experts say investing will reap rewards that benefit many investors. Monica Sipes is a certified financial planner and senior wealth advisor at Exencial Wealth Advisor. She says that long-term investing is key to having more winners in the stock market.
“I’m investing in X for this reason, and I’m willing to stomach the volatility and the risk associated with investing. I know these returns are predictable, based on history,” said Sipes.
Tracey Gordon is a communications strategist in New York. She said that long-term investing leads to a growth in benefits for investors.
“Small pieces grow and, with the magic of compounding, they make a huge difference,” said Gordon.
Investor Morgan Housel says business can’t be a zero-sum game because stakeholders and business owners benefit from investments.
“Every business has three main stakeholders: Customers, employees, and shareholders. You can ignore any one of those for a while, but eventually all three have to be cared for. Otherwise they’ll revolt, and no company can survive when any one of the big three walks out,’ said Housel.
“Many companies can take care of one, many can do two. But getting all three aligned is brutally hard, because the easiest way to appease one group is at the expense of another. That’s why the rewards for those that can find the balance are so great,” said Housel.
In addition to win-win investing, impact investing can help reduce zero-sum thinking about trading. Dutch investing firm CEO Altera Vastgoed Jaap van der Bijl spoke about how his firm helps investors and the environment.
“We are strong believers in impact investing,’ said Vastgoed. “Making your assets future-proof is a win/win for both investors and tenants, delivering returns to one and creating value for the other”.
‘We have set our goals on sustainability and we are very ambitious for a good reason,’ said van der Bijl. ‘We are delivering a dual return, financial and impact, and preparing for the future because we are spreading out our capex[capital expenditure] and also making returns more predictable for an unforeseen future, which is very attractive for investors who have long-term liabilities’.
In addition to Altera Vastgoed, Third Economy is sustainable as well. The investment research firm combines research with sustainability.
“Most investors want to make money while supporting causes they care about but have been lacking an easy way to understand how their investments contribute to a sustainable economy. With the launch of VIA, Third Economy is filling that gap,” said Third Economy CEO and Founder Chad Spitler. “The depth of insight previously only available to the world’s largest investors is now accessible to all investors.”
Alex Bryan is Morningstar’s director of passive strategies research for North America. He said that ESG (Environmental, Social, and Corporate Governance) investing is vital to having investments that benefit the company and all investors.
“There’s a great realization today that ESG issues are investment issues,” said Bryan.
“They’re issues that can affect the bottom line, and that may not always be something that comes to bear immediately. But it’s something that I think more people are starting to understand is aligned with shareholder value maximization,” added Bryan.
“The COVID-19 pandemic and movement for racial justice in the U.S. have kept attention on social issues, including workplace safety and diversity, and have likely added to interest in sustainable funds,” said Morningstar.
In contrast to the cutthroat zero-sum game of trading with only some winners, sustainable investing seeks to benefit all investors. Morgan Stanley noted that more investors want to pick stocks in companies that help investors and society.
“Increasingly proactive, they [individual investors] seek products and solutions across asset classes tailored to their interests. They also want to measure the environmental and social impact of their investments,” said Morgan Stanley.
ClearBridge portfolio manager Derek Deutsch noted that he wants to invest in companies that benefit investors and their communities as well. His investment strategy contrasts the zero-sum belief that some investors must win at all costs.
“We want companies with sustainable competitive advantages, and that would include excellent corporate governance, and companies that treat their employees well, interact in a positive way in communities where they’re located, etc.,” said Deutsch.
Hedge fund founder Cliff Robbins said many investors now want to pick stocks that have a positive impact on investors and the world at large.
“The largest investors in the world, which control how stocks are ultimately valued, care about this. Endowments and foundations are totally focused on ESG considerations … pension funds care about it, labor unions care about the safety of their employees … the biggest asset managers in the world have now awoken and said ‘ESG matters to me,’ and therefore it’s going to matter to companies,” said Robbins.
Financial writer Chris Farrell wrote that a recent survey found that sustainable investing is crucial before they pick a stock.
“And they found that more than half of the people they surveyed consider sustainable and responsible investments as safe havens, which in a way makes sense because companies with strong records on employee relations, environmental sustainability, corporate governance — they tend to do well over the long haul,” said Farrell.
Farrell also noted that a study of mutual fund investors found that ESG investments are crucial. The study revealed that mutual funds that had sustainable investments that benefited all investors performed well at the height of COVID-19.
“They found that mutual funds with high ESG ratings … have performed particularly well against various benchmarks during the pandemic. And so the results were particularly strong for those funds that have an environmental focus,” wrote Farrell.
Many investment firms see sustainable investment as key for investors. Pzena Investment Management ESG analyst Rachel Segal said that she may reject stocks that are sustainable. She notes that the stocks in her portfolio must go against the zero-sum game mentality.
“Sometimes we might reject a stock for an ESG reason. Sometimes we might actually see that the ESG reason is part of the reason why the stock is cheap, but also part of the potential turnaround, and we have confidence in management to help fix some of those issues. This ESG-lens is one of the many ways in which the firm approaches a stock”, said Segal.
“From our perspective, it’s really about the material risks to the investment and understanding how we can analyze those in a way to try and get the best risk-adjusted performance for our clients,” added Segal.
Calvert International Equity Fund Ian Kirwan noted that sustainable ESG investing presents a more holistic view of trading. He noted that a zero-sum game mentality to investing isn’t as rewarding to his fund.
“We use ESG as a source of information to hopefully tell us something about the investment we’re looking at. We don’t treat it with anything special … it is one of a number of different components that we use to paint the holistic picture,” said Kirwan.
A zero-sum game approach to trading and investing may be beneficial to traders who want to trade forex or options. With those industries, there are obvious winners and losers with trades. The zero-sum sum trading may also be best for day traders who want a quick profit at all costs.
However, if traders want to hold their investments for a long time, a zero-sum mentality may not be best. The zero-sum trading belief will also not be good for investors who care about all investors being able to profit from trades. No matter how a trader looks at the stock market, TradingSim’s charts and blogs can help them simulate trading to find the best stocks for their portfolios.
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